How to Use Your Tax Refund to Boost Credit

If you’re expecting a refund, tax season can be exciting. While it may be tempting to spend that extra cash on a vacation or a big purchase you’ve been putting off, your tax refund can also be an opportunity to boost your credit.

Putting at least part of your refund toward your credit can help you qualify for better loan terms, lower interest rates, and unlock more financial responsibilities.

Using your tax refund to improve your credit score is a wise investment that can save you thousands of dollars in interest payments. The question is, what’s the best use of your refund? Should you pay down debt, start a credit-building account, or catch up on overdue bills? Discover how to use your tax refund to improve your credit score.

Ways to use your tax refund to improve your credit score

Depending on the amount of your tax refund, you may be able to make progress toward multiple financial goals this tax season.

However, individuals who receive more modest refunds should typically focus on one goal that will positively impact their score and financial situation.

Before deciding how to use your tax refund, make sure you consider all of your options. Here’s how to use your tax refund to improve your credit score.

1. Pay down credit card balances

One of the smartest ways you can use your tax refund is to reduce your credit card balances.

The major credit scoring models consider your credit utilization rate when calculating your score. Your utilization rate is the percentage of available credit you’re using. Lowering your balances can reduce your utilization rate, which could improve your score as soon as the next billing cycle.

For example, imagine you have a credit card with a $5,000 limit and a $3,000 balance. That means you are using 60% of your available credit. If you applied a $2,000 refund toward that balance, your utilization would drop to $1,000 (20%). Paying down your credit card debt in a lump sum also reduces the amount of interest you’ll pay over time.

2. Pay off past-due accounts or collections

If you’ve fallen behind on payments, it’s a good idea to use your tax refund to get caught up. The major scoring models give the most weight to your payment history, which means that missing payments can wreck your score.

If an account has already gone to collections, paying it off won’t remove it from your credit report right away. However, resolving your outstanding debts is something lenders take notice of. Some collection agencies may even give you the chance to settle for less than the total balance if you can pay a lump sum.

Before you use the refund, review your credit report so you can identify which accounts require the most pressing attention. That way, you can prioritize where your refund will have the greatest impact.

3. Make advance payments on installment loans

If you are current on all payments, you could make extra principal payments toward a vehicle or personal loan. Making even a few extra payments’ worth of principal could save you money on interest and reduce your overall debt.

Paying down installment loans doesn’t usually improve your credit score as quickly as lowering the balance of a credit card, but it is still a wise move.

Before you make an extra payment, confirm with the lender that the funds will be applied directly to the principal. You don’t want the lender to apply the money toward future payments, as those payments will include both principal and interest.

4. Start an emergency fund to protect your credit

Improving your credit isn’t only about paying off debt. It’s also about avoiding future setbacks, like missing payments or taking out loans to cover surprise expenses.

If you don’t have an emergency fund or it doesn’t contain enough cash to cover 3-6 months of expenses, use at least some of your tax refund to boost your savings.

An emergency fund can help you cover unexpected expenses, meaning you won’t have to rely on credit cards or personal loans when life throws a financial surprise your way.

5. Open a credit-building account like Kikoff

If you’re just starting your credit journey or trying to bounce back after a rough patch, a credit-building account can be a great tool. These accounts report your on-time payments to one or more of the three credit bureaus so that you can establish a positive payment history.

Kikoff offers credit-building services, including an invite-only credit-builder loan and a secured credit card. These tools are made to support individuals who want to build a better score through consistent positive behavior.

6. Dispute errors on your credit report

You are entitled to one free credit report per year from each of the three major bureaus. If you aren’t sure how to use your refund for credit building, request your credit report first. Identify delinquent accounts, collection accounts, or your largest balances. Look for errors in your report and file a report with the appropriate bureau.

How to decide which strategy is right for you

The best way to spend tax refund on credit-building will vary based on how much money you get back and your current financial health.

If you are juggling a lot of bills and your tax refund will barely make a dent in your total debt, consider using it as an emergency fund instead. On the other hand, if you could eliminate a monthly payment with your refund, it could provide immediate relief in your budget.

What’s the best way to spend tax refund on credit-building?

Now that you know what your options are for using your tax refund, it’s time to pick a path that will support your short- and long-term financial goals. Tools like Kikoff can help you get more bang for your buck by offering practical steps toward a stronger credit score. Explore Kikoff and create a free account today to learn more.